Will new government regulation hurt self-managed superannuation funds?

A prominent ex-Liberal is lobbying in the interests of the big superannuation funds.

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There are some genuine concerns that the ability of self-managed superannuation funds (SMSFs) to borrow to buy property could over-inflate property prices. It's also possible that if people are not careful, they may be ripped off by unscrupulous financial advisers. Taking advantage of this, John Brogden, the former leader of the NSW Liberal Party, is pressuring the government to increase the regulatory burden on SMSF trustees.

Speaking to the Australian Financial Review, Assistant Treasurer Arthur Sinodinos noted that "since the global financial crisis there has been an upsurge in interest through investing in self-managed super funds." He continued: "In the super space we need to make sure it's a level playing field and that you get appropriate competition between the different funds, the industry funds, the self-managed super funds and that's the starting point,"

The government seems intent to ignore the real reason people are abandoning retail funds. During the GFC, such funds lost their members billions of dollars, yet still charged hefty management fees. If there is any part of the superannuation system that needs tougher regulation, it's the big funds that pay commissions to advisors and charge perverse fees.

Most funds charge "management fees" that are based on a percentage of the funds under management (FUM). This incentivises managers to grow funds under management, but is a very weak incentive to perform well. In order to market their fund, such funds seek to avoid volatility, which they confuse with risk, and stick closely to the index. During the financial crisis, many of these funds lost their members significant proportions of their wealth, but still helped themselves to management fees, usually in the range of 1-2% of FUM.

Some superannuation funds simply add an additional layer of fees. For example, members of Colonial FirstChoice Superannuation who choose the Fidelity Australian Equities Fund option pay a 1.54% management fee, a $60 a year "investor fee" and 0.2% transaction fees. In comparison, the Fidelity Australian Equities Fund charges investors a 0.85% management fee and 0.25% transaction fees. Colonial therefore takes a 0.69% management fee without adding much value. Why wouldn't you just set up your own SMSF and invest directly?

One notable impact of the increase in self-managed super is the popularity of dividend paying shares such as Commonwealth Bank (ASX: CBA) and Telstra (ASX: TLS). This is partly due to the favourable tax treatment of superannuation funds and the ability for SMSFs to pay out dividends as a pension.

Foolish takeaway

New restrictions on SMSFs might address the amount that such funds can borrow. This makes sense, because leverage can be very dangerous in investing. Investors should generally avoid borrowing money to invest in shares because the stock market can stay irrational longer than borrowers can stay solvent.

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Motley Fool contributor Claude Walker does not own shares in any of the companies mentioned in this article. Find him on Twitter @claudedwalker.

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